By Michael Every of Rabobank
Crash! Bang! Wallop! What a Daily!
Today’s obscure Alan Partridge title reference was inspired by a Tweet from The Economist’s @Birdyword in response to @CathieDWood arguing, “Volcker doubled the Fed Funds from 10% to 20% in less than a year. Powell’s Fed has increased the funds rate 7-fold in the lasty year and is pointing to another double from here. Its moves already are more draconian than Volcker’s”.
Volcker doubled the Fed funds from 10% to 20% in less than a year. Powell’s Fed has increased the funds rate 7-fold in the last year and is pointing to another double from here. Its moves already are more draconian than Volcker’s.— Cathie Wood (@CathieDWood) June 19, 2022
His simple rebuttal was a screenshot from the ‘Father Ted’ episode where Father Crilly uses plastic toy cows to try to explain to idiot Father Dougal the difference between ‘small’ and ‘far away’.
Wood’s ARKK fund is -9.8% on the last month, -59% year-to-date, and -75% from its all-time peak: in short, it is now both small(er) AND far away from its best. Yet clearly from her tweet, Wood does not get the punchline of real Fed funds still being highly negative (vs. CPI) regardless of how much it has risen from very, very small levels in percentage terms. We are very, very far from Volcker territory.
We are nonetheless heading for more crashes, bangs, wallops --and corresponding Dailies-- because of how much more financialised and deindustrialised the US economy is now than under Tall Paul. As the US comes back from holiday, let’s see how overly-leveraged, fictitious-over-productive-capital markets handle the increasing talk of a back-to-back 75bps from the Fed next month as a starter.
Tellingly, commodities are on the back foot. For all of the talk of ‘China’ and ‘stimulus’ and ‘property rebound’, which China’s own property experts CRIC refute, its markets saw a plunge in key metals and energy prices yesterday. More broadly, energy is also not trying to pop back up again yet. However, overall commodities still look to be more a ‘wallop’ than a ‘crash’ – at least until US rates get to a high enough level to flush out speculation and hoarding in a big ‘bang’… and we finally get to see how much real demand there is, and how much is ‘small vs. far away’.
Indeed, as noted yesterday, Europe --like China-- is plunging back into coal production again as Russian gas-flows tail off rapidly. The EU is chastising individual European countries for this backsliding, which makes sense in terms of a green strategy using future technology and future inputs, but little in terms of being able to keep the lights on this winter with current ones.
The US is also flailing for a response to high gasoline and diesel prices, and we have now seen two floated solutions: 1) subsidy cards for consumers - stymied by the US not having the chips to even make them, which speaks volumes about supply-side problems; and 2) that the US --like China-- should start a state oil refinery to reverse the 5% drop in capacity since Covid, but would still take years to happen, even if were politically ‘acceptable’, which it isn’t.
The food situation, linked to energy, looks even worse. The Ukrainian think tank The Centre for Defence Strategies claims Russian soldiers are forcing Ukrainian farmers to sell 70% of their crops to Russian buyers at a 90% discount, or are preventing it being transported to areas still controlled by Kyiv; in effect using hunger as a weapon of war. But you don’t have to listen to the Ukrainians on this – you can listen to the Russians. At their ‘Davos’ in St Petersburg, we just heard Margarita Simonyan state, “all our hope is in the famine.” This “cynical joke” heard “across Moscow” means “the famine will start now: and they will lift the sanctions and be friends with us, because they realize it’s impossible not to be friends with us.”
Yes, President Putin said otherwise at the same venue recently. But people say lots of things and don’t mean them. Like they won’t invade Ukraine. Or ‘Build Back Better’. Or they won’t militarise man-made islands in the South China Sea. Or they won’t interfere with US energy production.
For both energy and food, the northern hemisphere winter is coming. And peace is not. Indeed, Lithuania’s land blockade of the rail route to the Russian enclave of Kaliningrad, entirely ignored by the world media at first, now picked up on, only escalates tensions. It remains to be seen what the response will be, but if it isn’t military then it will be like-for-like economic war: less gas, less food, more looking the other way and whistling as chaos then ensues. This isn’t a bug, it’s a feature.
Meanwhile, geopolitics is becoming predictably unpredictable:
- Europe is full of problems, as is the UK, and both are raising problems for each other.
- Turkey and Greece are at serious loggerheads.
- Africa is seeing less European influence just as its resources become more vital to the EU.
- US ally Colombia voted in a former rebel leftist as president, shifting LatAm further from the US orbit - the next key election is Brazil on 2 October.
- Israel will call new elections for 25 October, which will likely produce unstable/caretaker Prime Minister Lapid or a comeback for Netanyahu.
- There is a flurry of activity in the Middle East centred around Iran, more of whose nuclear scientists are suddenly dying.
- Tensions in the Taiwan Straits are escalating as China claims they are not international waters, just after announcing its armed forces can operate abroad outside of declarations of war.
- The Uyghur Forced Labor Prevention Act (UFLPA) goes into effect today, blocking all imports to the US originating in whole or part from Xinjiang – though if/how this will be enforced remains to be seen.
- In ASEAN, the Philippine Senate just adjourned its last session without ratifying the Regional Comprehensive Economic Partnership (RCEP) agreement due to objections that accession will harm the country’s farmers.
- Even Kazakhstan and Russia just blocked each other’s oil and coal exports.
Against this befuddling supply-side backdrop is there a way to raise rates without a crash (bang wallop)? No. But if rates aren’t raised, is there any way to avoid a different kind of inflationary crash (bang wallop)? No. Central banks are in trouble whatever happens.
Tellingly, the AFR reports Treasurer Chalmers has overridden RBA Governor Lowe’s wishes and will appoint a panel of independent experts to review it, including a monetary policy expert from overseas. (NB, that won’t be me.) The review may consider the composition of the RBA board, the appointment processes, and the 2-3% CPI target. The AFR states, “some observers believe the board should have more professional economists to challenge the governor and deputy governor on technical monetary policy issues.” I would personally hope they have fewer economists and more logistics experts, and perhaps even a general. Then again, “some officials are concerned that any move to amend the legislation would risk the Greens in the Senate trying to add climate change and inequality to the bank’s mandate.”
The RBA is already conducting an internal review of its Covid policies, such as the 0.1% cash rate it pledged not to raise until 2024, as today Lowe stated 4% was unlikely but not entirely out of the question by year-end, and that inflation will remain above target “for years”. There are also questions over A$350bn in QE and A$188bn in cheap loans to commercial banks. Yet the RBA is also under attack for its claims of "stronger upward pressure" on wage growth, a view originating from its liaison program, which is criticised as statistically imprecise.
"I think the RBA had dug itself into a hole whereby it needed evidence that wages growth was starting to accelerate in order to satisfy its precondition for starting to raise rates, that underlying inflation was sustainably within the 2-3% target range," says former ANZ chief economist Saul Eslake. You mean a central bank might not ‘follow the science’?! Then again, the minimum wage did just rise 5.2%, and today’s minutes underlined that “The Board remains committed to doing what is necessary to ensure that inflation in Australia returns to the target over time.”
Meanwhile, in China we may have a significant policy shift too. A PBOC notice yesterday flagged changes to “give full play to the role of cross-border RMB settlement business in serving the real economy, promoting trade and investment facilitation, and support the development of new forms of foreign trade.” This includes that domestic banks can cooperate with non-bank payment institutions and legally qualified clearing institutions that have obtained internet payment business licenses for cross-border RMB clearance, i.e., cross-border e-commerce, market procurement trade, overseas warehouses and foreign trade services, and consumers who purchase goods or services. Maybe it’s nothing: and maybe it’s warming up for the use of e-RMB to trade across internet apps outside of SWIFT.
I don’t think any major central bank is going to emerge from what is about to happen with its reputation enhanced or its current operating parameters intact. Very few are going to make it into the Ark: most will look like ARKK.
That prospect is neither small nor far away: markets should prepare for the associated crashes, bangs, and wallops.